Keep City Bonds Tax-free

April 12, 1986

Local governments will be struggling for years to adjust to the sharp cuts in federal aid due to begin this fall. This is no time for Congress to add to their burden by making it more expensive for them to borrow.

As part of his comprehensive tax bill, Sen. Robert Packwood proposed taxing a portion of the interest earned by people who hold large amounts of municipal bonds. He argued that it`s the only way to get at wealthy individuals who invest heavily in municipals to avoid paying federal income tax, and he has a point. But his proposal would make the bonds less attractive to buyers, forcing up the price for financing city projects. And that would hurt lower-income taxpayers as well as the affluent ones Mr. Packwood wants to reach.

He heads the Senate Finance Committee, so even though his proposal was in the infancy stage it traumatized the municipal bond market. The committee reacted quickly, rejecting the retroactive language in his plan. It should go all the way, preserving the tax-exempt status for all municipals--new as well as old--so long as they are used for government projects.

The tax bill passed last fall by the House has the right approach. It keeps the exemption for public-purpose municipal bonds but subjects new private-purpose bonds to a minimum tax. This gives a break to financially strapped cities without doing much damage to the federal treasury. About two- thirds of all the tax-exempt bonds issued annually are used for private projects, not public ones. And the volume of private-purpose bonds has been growing much faster in recent years than the public issues.

The House bill also imposes a per-resident ceiling on the dollar amount of bonds that cities and states can authorize for such private purposes as housing, student loans and industrial growth. Some private projects no longer would be eligible for this form of tax subsidy, including convention centers, airport hotels and sports stadiums. (Except, of course, for those grandfathered in by friends on the tax-writing Ways and Means Committee. Two proposed Chicago-area stadiums--one in the south Loop and one in Addison--got granddad status, thanks to committee chairman Dan Rostenkowski.)

Treasury Secretary James Baker thinks all new municipals should be subject to some form of federal tax. He`s looking at the matter solely from the perspective of a federal official, so his position is understandable. But for people worried about the solvency of their local governments as well as their federal government, the House bill is more equitable.